A Successful Contracting Business Starts With Understanding Overhead

Why are you in business? Regardless of whether you hate your job and drag your ass to work or jump out of bed at 4:30 every morning like it’s Christmas, your goal at the end of the day, is to make money. Yet most contractors stink when it comes to all matters pertaining to capital. We can’t estimate, budget, save, job cost, pay taxes, pay vendors, pay subs or pay ourselves with any consistency or confidence. Ask most contractors if they are making any money and their answer will be something along the lines of “I think so…” How do I know? Because I’m one of em!

Why is that?

Most of us start out working with our hands and the money is an afterthought, something we will figure out later. We get the job, do the job, then get paid for the job, then we try and figure what to do with the money. This mentality is the reason why 1 out of 10 small businesses fail within the first 5 years and only 10% of those make it past year 10.

We have it backwards

The money and the business itself should come first. If you ever look to buy an existing business, the first question you will ask is, “How does it make money?” How we make money as contractors is more than just the work we do with our hands and getting paid at the end. It starts with an understanding of 4, not so basic principles pertaining to money.

MARK UP

MARGIN

PROFIT

OVERHEAD

Definitions

Markup The amount added to the cost price of goods and services to cover overhead and profit.

Margin Refers to the difference between selling price and the seller’s costs for the goods or services they sell, expressed as a percentage of selling price.

Profit a financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something.

Overhead is any indirect expense that supports the making or selling of a product or service. Ie truck and fuel expenses.

Like Stephen Covey says in his book “The 7 habits of Highly Effective People”, start with the end in mind. (the goal) For any business owner, that end should be profit. When the dust clears how much do you want in your pocket? Whether that’s every Friday or the end of a particular job, knowing this number is crucial to getting a grip on your business and your finances. Profit is the why. It’s why you invest in a stock and it’s why you invest your time and effort into your business. But before we can even start thinking about profit we have to understand one thing first.

OVERHEAD

Mr Wonderful from the tv show Shark Tank often says “You better know your numbers” Knowing your numbers starts with the basic understanding of what it takes to run your business and one of your biggest numbers is overhead. Your fixed costs that you have to pay whether you are making money or not. This number is just as critical if you are a guy in a van or a design build firm with a dozen employees. Know your overhead, first as a yearly amount and then broken down monthly.

I have attached a copy of my company’s overhead statement from 2016 so you can get an idea of how to calculate your own.

What is important to understand about this spreadsheet is the 2 numbers at the end. The first is the total sales in 2016 and the 2nd is the overhead expressed as a percentage of those sales. In 2016 23.4% of total revenue went towards overhead.

Now what? How will this help me and you? Well, hopefully I priced my jobs accurately in 2016 and that includes accounting for my overhead needs accurately. More importantly however, is how this will help me going into the next year. I now have concrete data on what my overhead burden will look like. Assuming that my sales will be similar to the previous year, I can build in a 23.4%* MARGIN into all of my jobs to cover overhead. (Note that I said margin and not mark up. I will dive into that difference in Part II.) * BTW I round up to 30% to give myself some breathing room.

Can you imagine trying to run a business and pricing jobs accurately without knowing what this number is? It cost just less than $200k in 2016 just to keep boots on the ground and If we are not pricing this expense into every job , then we will not stay in business for very long.

The next key is to anticipate what the next year might be like for your business and of course this is where most business owners jump off because they simply have no idea where to start. Taking a look back at your last 3 years will be helpful. See where your gross sales have been trending over the last 3 years. Have they been increasing, decreasing or fluctuating? Take this information and make your best guess and set a target for next year’s gross sales. Then, make a new column and insert your estimates for your anticipated expenses for the next year. If you are planning on making some changes in your fixed spending, then you should account for it here.

In 2016 I invested in some business coaching and consulting but would not have that expense again. I also purchased a new dump truck and excavator at the end of the year and planned on spending more on advertising and cutting back on some other expenses. I also factored in a 3% increase in both gross sales and overhead expenses after the adjustments. Here is what my projected overhead for 2017 looked like.

After all the adding and subtracting, my gross numbers went up, but my overhead expressed as a percentage of sales stayed practically the same.

We have all subscribed the Henry Ford model of accounting at one time or another. That is simply putting all the cash in a barrel and paying all your expenses from that and keeping what’s left over. You and I know it’s simply impossible to run any kind of successful business without knowing your overhead. Before you do anything else, take the time to learn what yours is and you will have a fighting chance at success.